Top German body calls for QE blitz to avert deflation trap in Europe

Head of German Institute for Economic Research demands €60bn of bond purchases each month to halt contraction of credit and avert Japanese-style trap

A leading German institute has called for full-blown quantitative easing by the European Central Bank (ECB) to head off a deflation spiral, marking a radical shift in thinking among the German policy elites.

Marcel Fratzscher, head of the German Institute for Economic Research (DIW) in Berlin, demanded €60bn (£50bn) of bond purchases each month to halt the contraction of credit and avert a Japanese-style trap.

“It is high time for the ECB to act. Otherwise Europe risks falling into a dangerous downward spiral of sliding prices and declining demand”, he wrote in Die Welt.

“The ECB must counter the deflation threat quickly and decisively, and launch a broad-based programme of bond purchase along the lines of the Federal Reserve,” he said. The scale should be 0.7pc of eurozone state debt each month, comparable to ‘QE3’ in the US.

The International Monetary Fund has warned that the deflation risk in the eurozone may now be as high as 20pc, leaving the region vulnerable to an external shock.

The DIW is one of the five German institutes with an official advisory role, and is a powerful voice in German affairs. The call for drastic action suggests that the country may be more open to a reflation strategy than assumed, and puts pressure on the two German members of the ECB council to tone down their vehement opposition to any form of QE.

The DIW said eurozone deflation is becoming “ever more probable”, making it that much harder for Italy, Spain, and Portugal to claw back lost competitiveness against the North. These countries have to carry out internal devaluations with deep cuts in wages and prices. This in turn plays havoc with the debt trajectory raises the risk of an interest compound trap.

“The outcome could be a vicious circle that is ever harder for the ECB to stop. Japan’s experience over the last twenty years shows how painful such a scenario can be.”

The DIW is effectively joining a chorus of economists in Europe and the US warning that the slow drift towards deflation is incubating a second and potentially more serious sovereign debt crisis once the next recession hits.

Full article: Top German body calls for QE blitz to avert deflation trap in Europe (The Guardian)

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